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Caucasus Business Forecast Report
January 1, 2015 Thursday
Q1 2015 - Everything Hinges On Nagorno-Karabakh
HIGHLIGHT: Attempts to win back the Nagorno-Karabakh enclave will
remain the defining issue of Azerbaijani foreign and domestic policy
through the medium term. No quick resolution is likely and, therefore,
heightened tensions with Armenia have the potential to result in
further small-scale armed clashes, with escalation not ruled out. This
will continue to weigh heavily on Azerbaijan's long-term risk profile,
which will deter investment despite progress on other fronts.
BMI View: Attempts to win back the Nagorno-Karabakh enclave will
remain the defining issue of Azerbaijani foreign and domestic policy
through the medium term. No quick resolution is likely and, therefore,
heightened tensions with Armenia have the potential to result in
further small-scale armed clashes, with escalation not ruled out. This
will continue to weigh heavily on Azerbaijan's long-term risk profile,
which will deter investment despite progress on other fronts.
Despite a relatively strong short-term outlook, we remain cautious on
Azerbaijan's long-term political risk outlook, given ongoing elevated
tensions with neighbour Armenia over the Nagorno-Karabakh enclave.
Since a war between the two countries in the 1990s (no peace deal has
been signed), ethnic Armenian forces have held the territory in
Nagorno-Karabakh in the Western part of Azerbaijan, establishing a
government and holding regular elections.
All Eyes On Nagorno-Karabakh
Europe - Map Of Caucasus Region
Download Table
The issue remains - and will remain - a major impediment to the
mitigation of political risk in the South Caucasus. The primary reason
for this is the estimated 500,000 displaced Azerbaijanis, many of whom
continue to live in temporary accommodation 19 years after the end of
the war. This has resulted in intense domestic political pressure on
the Azerbaijani government to take back the territory, exacerbated by
the lack of open elections that means the leadership must be
particularly sensitive to popular sentiment. Aggressive rhetoric from
Baku is not uncommon and the government has ramped up military
spending to US$3.7bn per year. Small-scale border clashes between
Azerbaijani and ethnic Armenian forces - often resulting in multiple
deaths - are not uncommon.
Challenges And Threats To Stability
Hot War: The major risk to political stability in Azerbaijan, and
indeed in the wider Caucasus region, is the outbreak of interstate
warfare with Armenia over Nagorno-Karabakh. Regular small-scale border
skirmishes could conceivably escalate into something bigger, while
aggressive rhetoric from both sides will ensure that tensions remain
high. It is estimated that 20,000 combat-ready troops are deployed on
each side of the border, often separated by just 50 metres, and the
fact that the soldiers are raised on radically different
interpretations of the region's recent history does not lend itself to
moderation.
That said, the outbreak of war remains outside our core scenario. One
reason for this is the regular contact between the Armenian and
Azerbaijani presidents since 2008 under the auspices of Russian
President Dmitry Medvedev, and his predecessor and successor Vladimir
Putin. The personal and public involvement of a powerful neighbouring
country that has relatively strong relations with both countries
(particularly Armenia) lends credibility to the peace process while
also mitigating the risks of a major breakdown. More importantly than
diplomatic initiatives, however, is the fact that the interests of
major regional players - Russia and Turkey - are in line with a
mitigation of tensions and the establishment of a lasting resolution.
Following the 2008 war with Georgia, Moscow is keen to reinforce its
credibility as a responsible actor in the region, while also seeking
to improve relations with Baku for the purposes of energy security.
For Ankara, a greater role in Caucasian security issues is a priority,
while it is also keen to keep Baku on side, again for reasons related
to gas. These factors should ensure that Baku feels it is getting a
fair hearing, while also discouraging any pre-emptive attack on
Nagorno-Karabakh.
Ructions With Turkey: We believe relations between Azerbaijan and
Turkey could deteriorate over the medium term, which would have the
potential to harm Azerbaijan's economic and political risk profile,
given the importance of its implicit backing from Ankara in
international affairs. Traditionally, Baku and Ankara have enjoyed
strong bilateral ties, symbolised by the popular slogan 'one nation,
two states'. Indeed, the two have similar cultures and languages, and
Ankara has had no diplomatic relations with Yerevan since 1993, in
solidarity with Baku.
However, an increase in tensions between the two has come about since
Ankara decided to pursue better relations with Yerevan, culminating in
the signing of two protocols on the re-establishment and development
of diplomatic ties in Zurich in October 2009. Baku was incensed that
Ankara had signed the protocols without demanding concessions on
Nagorno-Karabakh in return and promptly threatened to hike prices for
gas exports to Turkey. Turkish flags in Azerbaijan were also taken
down. Although tensions have mitigated substantially since, with the
signing of a key gas deal in Istanbul in June 2010 and the scheduled
construction of the Trans-Anatolian pipelines (TANAP), we believe
risks remain. Any perception that Ankara's support for Baku has
weakened would potentially reduce the latter's clout in regional
affairs.
Relations With Iran: We expect relations with Iran to remain tense
through the medium term for a number of reasons, which will further
weigh on Azerbaijan's risk profile. Foremost among these is Iran's
desire to increase its leverage over Baku both to increase access to
Azerbaijani oil and to boost Tehran's leverage over Moscow - something
that it currently lacks. In addition, Tehran will likely remain wary
of Azerbaijan's potential ability to destabilise Iran, given the
latter's large Azeri population (there are more Azeris in Iran than in
Azerbaijan). A further major sticking point between the two is Israel,
which will likely further fuel suspicion towards Baku in Tehran, given
that Azerbaijan pursues strong relations with Israel. Tehran has
accused Baku of allowing Israeli listening posts to be established
along its border with Iran while, for its part, Azerbaijan has
expressed discontent with Armenian-Iranian gas cooperation.
Democratic Limitations: Despite major improvements in living standards
on the back of rising oil revenues in recent years ( see chart), there
are signs that popular discontent with the government remains fairly
elevated.
Living Conditions Improving
Azerbaijan - Quality Of Life Indicators
Download Table
While no repeat of the violent protests of 2003 have yet been
witnessed, the lack of a strong opposition in parliament and President
Ilham Aliyev's strengthening hold on power have resulted in a number
of street protests in Baku in recent years. The authorities' control
on public gatherings outside the capital is much stronger, although
the protests in Ismayilli presented a new challenge to Aliyev.
Government critics are regularly harassed according to human rights
gorups, while trade unions are weak and media freedom has been
questioned by western observers. Although the government has so far
managed to handle domestic opposition relatively easily, we do not
believe democratic institutions are sufficiently well developed to
handle major public protest at this juncture, should it come about.
Corruption: Widespread allegations of corruption have helped to foster
resentment against the government. Azerbaijan came in at 127th place
out of 177 countries in Transparency International's 2013 Corruption
Perceptions Index, well below neighbours Georgia (55 th) and Armenia
(94 th). Given that those unhappy with government policy are often
unable to channel their concerns democratically, we see the potential
for further disenchantment to threaten political stability, curtailing
the government's policy agenda and damaging investor confidence.
Domestic Islamist Threat: Poverty, corruption and other concerns have
contributed to a growing militant Islamist movement in Azerbaijan.
While we see this as small at present, we nevertheless believe it has
the potential to grow significantly, which would pose major risks to
political stability. Although secular tendencies in Azerbaijan are
among the strongest of any majority Muslim country (religious
involvement with politics is forbidden by law), the militant minority
is growing. In October 2007, the government claimed that it had
thwarted a major attack against Western diplomatic missions in Baku,
while three people were killed in an attack on a mosque in 2008.
Rallies and protests using religious slogans have also become more
common on the streets of Baku.
Unclear Borders: The fact that Azerbaijan's borders with neighbouring
states are often ill-defined will remain a risk to political
stability. This is a particular problem given elevated regional
tensions, while the unclear divisions between states make border
controls difficult, limiting the government's ability to monitor the
potential arrival of members of radical terrorist groups.
Ratings: Stability Not Assured In Medium Term
Our political risk ratings make a clear distinction between what we
see as short-term stability and longer-term risks. In the near term,
robust oil revenues will allow sufficient social transfers to maintain
social stability, which will in turn provide the government with room
to continue its reforms of the business environment and increase its
attractiveness to foreign investors. Our short-term political risk
rating for Azerbaijan is 70.3 (out of 100), one of the highest in the
Central and Eastern Europe (CEE) region excluding the CE4. In line
with our key views, Azerbaijan scores most strongly on the 'policy
continuity' and 'policymaking process' components of our ratings - at
80.0 and 76.7 out of 100 respectively - while faring less well on
'security and external threats', where it tallies just 46.7 out of
100.
Over the longer term, we are less assured about political stability.
Although we continue to expect a mitigation of regional tensions at
some point, we believe the security situation in the Caucasus could
get worse before it gets better. This would have a greater relative
impact on political stability in Azerbaijan than in Georgia and
Armenia, in our view, given that its institutions are less well
prepared to handle the domestic implications of heightened tensions.
Azerbaijan's long-term political risk rating of 49.0 out of 100 puts
it lower down the CEE rankings, albeit still ahead of Georgia.
Azerbaijan fares worst in our 'characteristics of polity' (30.8 out of
100) category due to the relatively underdeveloped and closed nature
of its political and legal systems as well as the media. It also
struggles on the 'characteristics of society' component (52.5 out of
100), thanks to the potential for domestic opposition groups -
particularly Islamists - to hamper the policymaking process and due to
ongoing wealth disparities that have the potential to fuel
disenchantment with the government.
Our concern that Azerbaijan's institutions may be ill-equipped to deal
with the emergence or escalation of internal and external threats
relative to other CEE nations is demonstrated by the chart below,
which indicates the difference between our long- and short-term
political ratings. Aside from Turkmenistan and Kazakhstan, we believe
Azerbaijan is the CEE country where the political risk situation has
the greatest potential to deteriorate.
Scenarios For Political Change
While we believe domestic pressures from disenchanted groups could
impact the policy formation process in Azerbaijan through the medium
term, we forecast the major risk to political stability will come from
outside the country. Specifically, tensions with Armenia over the
disputed Nagorno-Karabakh enclave will dominate Azerbaijan's foreign
and domestic policy as long as hundreds of thousands of internally
displaced Azerbaijanis are unable to return to their former homes in
the region.
Best Case Scenario - Mitigation Of Regional Tensions: The best case
scenario for Azerbaijan's long-term political risk profile is a
resolution to its dispute over Nagorno-Karabakh. Any solution would be
threefold, involving an agreement on the terms of a future referendum
for the region's inhabitants, a roadmap for the return of displaced
Azerbaijanis to their former homes under the protection of a
multinational peacekeeping force as well as a mutually accepted
decision on who will control the Lachin corridor, a land route between
Armenia and Nagorno-Karabakh.
This would require two things. First, the continued involvement of
regional heavyweights Russia and Turkey, as well as major Western
countries such as the US and France (which, along with Russia, make up
the OSCE Minsk Group charged with coordinating discussions between the
disputed parties). It would also require the involvement of the ethnic
Armenian government of Nagorno-Karabakh - something that Baku may find
difficult to stomach. Second, it would require a major investment of
political capital by the presidents of Armenia and Azerbaijan. Both
are under intense domestic pressure to ensure that their key goals are
met over the enclave. Given that many of the countries' demands are
incompatible (ie Baku wants Nagorno-Karabakh to remain part of
Azerbaijan while Armenia wants the future referendum to include the
possibility of full independence), this will require the presidents to
go against popular domestic sentiment to secure a deal.
Should this scenario play out, we would expect it to substantially
improve Azerbaijan's political risk profile and significantly mitigate
regional tensions. This would bolster investor confidence, paving the
way for a ramping up on foreign direct investment, aiding the
government's attempt to diversify the economy away from its dependence
on oil and gas revenues.
Intermediate Scenario - Tensions Kept In Check: A far more likely
scenario is for tensions to be kept in check, without a major
improvement in relations or significant progress towards a mutually
acceptable solution on the enclave's future status. This would involve
the two sides continuing to talk and for Russia, Turkey and key
Western countries to maintain an important role in the dialogue. Under
this scenario, a stable platform would be provided for the discussion
of key sticking points, which would increase the chances of a
breakthrough.
The two sides continuing to talk would in itself increase investor
confidence, as long as the meetings are conducted regularly and
produce evidence of progress. In tandem with Azerbaijan's improving
business environment, this would bolster investor sentiment. At this
juncture, we see this scenario as the most likely to play out.
Worst Case Scenario - War: While the outbreak of war is always
difficult to predict, we believe that if war was to break out anywhere
in CEE in the next five years, it will be in Nagorno-Karabakh between
Armenia and Azerbaijan. As long as both sides continue to employ
aggressive rhetoric and regular exchanges of fire occur on the border,
there will always be the chance of a resumption of interstate war.
We caution, though, that this is highly unlikely to happen. This is
mainly because Russia - which still has 3,000 troops stationed in
Armenia - would likely step in, while Turkey would also likely make a
major effort to prevent an outbreak of fighting. The risk is that the
number of troops stationed on the border in close proximity to each
other could mean the situation would develop too rapidly for
international actors to be able to influence events, meaning that by
the time Moscow, Ankara and Western capitals were able to step in, the
damage may have already been done.
As long as the threat of war remains - and we fully expect it to -
investor risk sentiment will remain elevated and Azerbaijan will
struggle to attract the levels of foreign direct investment that it
needs to diversify its economy away from energy export. This will keep
it dependent on external demand, which poses the risk that a global
slowdown in economic growth results in a stronger domestic opposition
that could, in turn, hurt the government's reform agenda.
An outbreak of interstate warfare would hammer investor confidence,
leading to a massive withdrawal of funds from Azerbaijan and the wider
region, as well as undoing much of the economic growth that has been
achieved in the past 10 years. While Azerbaijan is not as dependent on
foreign capital flows as Georgia, the latter's experience of the 2008
war with Russia emphasises the extent to which warfare can damage
investor sentiment.
Political Overview Table
System of Government Presidential Republic (five-year term);
Unicameral 125-seat Milli Mejlis (National Assembly) (five-year term);
Universal suffrage. Executive power rests with the President.
Head of State President Ilham Aliyev; Three five-year terms
Head of Government Prime Minister Artur Rasizade
Last Election Parliamentary - November 7 2010
Presidential - October 9 2013
Government Formation Council of Ministers: appointed by the President
and confirmed by the National Assembly
Key Figures Finance - Samir Sharifov; Internal Affairs - Ramil Usubov;
Defence - Zakir Hasanov; Foreign Affairs - Elmar Mammadyarov; Energy -
Natiq Aliyev; Justice - Fikret Mamedov; Chairman of the National Bank
- Elman Rustamov
Key Political Forces (number of seats in parliament) New Azerbaijan
Party (Yeni) (72): Ruling political party. Founded by former President
Heydar Aliyev in 1993.
Civil Solidarity Party (3): opposition party which stands for the
civil unification of Azerbaijani people. Established in 1992 by Sabir
Rustamkhanly.
Motherland (2): Small pro-presidential party. The party was founded in
1992, and is led by former First Deputy Minister of Labor and Social
Protection, Fazail Agamali.
Independents (48)
Next Election Parliamentary - 2015
Presidential - 2018
Ongoing Disputes Nagorno-Karabakh
Key Relations/ Treaties Member of the Commonwealth of Independent
States. Member of the Organisation of the Black Sea Economic
Cooperation (BSEC)
BMI Short-Term Political Risk Rating 70.8
BMI Structural Political Risk Rating 49.0
Download Table
Source: CIA World Factbook, BMI
January 1, 2015 Thursday
Q1 2015 - Everything Hinges On Nagorno-Karabakh
HIGHLIGHT: Attempts to win back the Nagorno-Karabakh enclave will
remain the defining issue of Azerbaijani foreign and domestic policy
through the medium term. No quick resolution is likely and, therefore,
heightened tensions with Armenia have the potential to result in
further small-scale armed clashes, with escalation not ruled out. This
will continue to weigh heavily on Azerbaijan's long-term risk profile,
which will deter investment despite progress on other fronts.
BMI View: Attempts to win back the Nagorno-Karabakh enclave will
remain the defining issue of Azerbaijani foreign and domestic policy
through the medium term. No quick resolution is likely and, therefore,
heightened tensions with Armenia have the potential to result in
further small-scale armed clashes, with escalation not ruled out. This
will continue to weigh heavily on Azerbaijan's long-term risk profile,
which will deter investment despite progress on other fronts.
Despite a relatively strong short-term outlook, we remain cautious on
Azerbaijan's long-term political risk outlook, given ongoing elevated
tensions with neighbour Armenia over the Nagorno-Karabakh enclave.
Since a war between the two countries in the 1990s (no peace deal has
been signed), ethnic Armenian forces have held the territory in
Nagorno-Karabakh in the Western part of Azerbaijan, establishing a
government and holding regular elections.
All Eyes On Nagorno-Karabakh
Europe - Map Of Caucasus Region
Download Table
The issue remains - and will remain - a major impediment to the
mitigation of political risk in the South Caucasus. The primary reason
for this is the estimated 500,000 displaced Azerbaijanis, many of whom
continue to live in temporary accommodation 19 years after the end of
the war. This has resulted in intense domestic political pressure on
the Azerbaijani government to take back the territory, exacerbated by
the lack of open elections that means the leadership must be
particularly sensitive to popular sentiment. Aggressive rhetoric from
Baku is not uncommon and the government has ramped up military
spending to US$3.7bn per year. Small-scale border clashes between
Azerbaijani and ethnic Armenian forces - often resulting in multiple
deaths - are not uncommon.
Challenges And Threats To Stability
Hot War: The major risk to political stability in Azerbaijan, and
indeed in the wider Caucasus region, is the outbreak of interstate
warfare with Armenia over Nagorno-Karabakh. Regular small-scale border
skirmishes could conceivably escalate into something bigger, while
aggressive rhetoric from both sides will ensure that tensions remain
high. It is estimated that 20,000 combat-ready troops are deployed on
each side of the border, often separated by just 50 metres, and the
fact that the soldiers are raised on radically different
interpretations of the region's recent history does not lend itself to
moderation.
That said, the outbreak of war remains outside our core scenario. One
reason for this is the regular contact between the Armenian and
Azerbaijani presidents since 2008 under the auspices of Russian
President Dmitry Medvedev, and his predecessor and successor Vladimir
Putin. The personal and public involvement of a powerful neighbouring
country that has relatively strong relations with both countries
(particularly Armenia) lends credibility to the peace process while
also mitigating the risks of a major breakdown. More importantly than
diplomatic initiatives, however, is the fact that the interests of
major regional players - Russia and Turkey - are in line with a
mitigation of tensions and the establishment of a lasting resolution.
Following the 2008 war with Georgia, Moscow is keen to reinforce its
credibility as a responsible actor in the region, while also seeking
to improve relations with Baku for the purposes of energy security.
For Ankara, a greater role in Caucasian security issues is a priority,
while it is also keen to keep Baku on side, again for reasons related
to gas. These factors should ensure that Baku feels it is getting a
fair hearing, while also discouraging any pre-emptive attack on
Nagorno-Karabakh.
Ructions With Turkey: We believe relations between Azerbaijan and
Turkey could deteriorate over the medium term, which would have the
potential to harm Azerbaijan's economic and political risk profile,
given the importance of its implicit backing from Ankara in
international affairs. Traditionally, Baku and Ankara have enjoyed
strong bilateral ties, symbolised by the popular slogan 'one nation,
two states'. Indeed, the two have similar cultures and languages, and
Ankara has had no diplomatic relations with Yerevan since 1993, in
solidarity with Baku.
However, an increase in tensions between the two has come about since
Ankara decided to pursue better relations with Yerevan, culminating in
the signing of two protocols on the re-establishment and development
of diplomatic ties in Zurich in October 2009. Baku was incensed that
Ankara had signed the protocols without demanding concessions on
Nagorno-Karabakh in return and promptly threatened to hike prices for
gas exports to Turkey. Turkish flags in Azerbaijan were also taken
down. Although tensions have mitigated substantially since, with the
signing of a key gas deal in Istanbul in June 2010 and the scheduled
construction of the Trans-Anatolian pipelines (TANAP), we believe
risks remain. Any perception that Ankara's support for Baku has
weakened would potentially reduce the latter's clout in regional
affairs.
Relations With Iran: We expect relations with Iran to remain tense
through the medium term for a number of reasons, which will further
weigh on Azerbaijan's risk profile. Foremost among these is Iran's
desire to increase its leverage over Baku both to increase access to
Azerbaijani oil and to boost Tehran's leverage over Moscow - something
that it currently lacks. In addition, Tehran will likely remain wary
of Azerbaijan's potential ability to destabilise Iran, given the
latter's large Azeri population (there are more Azeris in Iran than in
Azerbaijan). A further major sticking point between the two is Israel,
which will likely further fuel suspicion towards Baku in Tehran, given
that Azerbaijan pursues strong relations with Israel. Tehran has
accused Baku of allowing Israeli listening posts to be established
along its border with Iran while, for its part, Azerbaijan has
expressed discontent with Armenian-Iranian gas cooperation.
Democratic Limitations: Despite major improvements in living standards
on the back of rising oil revenues in recent years ( see chart), there
are signs that popular discontent with the government remains fairly
elevated.
Living Conditions Improving
Azerbaijan - Quality Of Life Indicators
Download Table
While no repeat of the violent protests of 2003 have yet been
witnessed, the lack of a strong opposition in parliament and President
Ilham Aliyev's strengthening hold on power have resulted in a number
of street protests in Baku in recent years. The authorities' control
on public gatherings outside the capital is much stronger, although
the protests in Ismayilli presented a new challenge to Aliyev.
Government critics are regularly harassed according to human rights
gorups, while trade unions are weak and media freedom has been
questioned by western observers. Although the government has so far
managed to handle domestic opposition relatively easily, we do not
believe democratic institutions are sufficiently well developed to
handle major public protest at this juncture, should it come about.
Corruption: Widespread allegations of corruption have helped to foster
resentment against the government. Azerbaijan came in at 127th place
out of 177 countries in Transparency International's 2013 Corruption
Perceptions Index, well below neighbours Georgia (55 th) and Armenia
(94 th). Given that those unhappy with government policy are often
unable to channel their concerns democratically, we see the potential
for further disenchantment to threaten political stability, curtailing
the government's policy agenda and damaging investor confidence.
Domestic Islamist Threat: Poverty, corruption and other concerns have
contributed to a growing militant Islamist movement in Azerbaijan.
While we see this as small at present, we nevertheless believe it has
the potential to grow significantly, which would pose major risks to
political stability. Although secular tendencies in Azerbaijan are
among the strongest of any majority Muslim country (religious
involvement with politics is forbidden by law), the militant minority
is growing. In October 2007, the government claimed that it had
thwarted a major attack against Western diplomatic missions in Baku,
while three people were killed in an attack on a mosque in 2008.
Rallies and protests using religious slogans have also become more
common on the streets of Baku.
Unclear Borders: The fact that Azerbaijan's borders with neighbouring
states are often ill-defined will remain a risk to political
stability. This is a particular problem given elevated regional
tensions, while the unclear divisions between states make border
controls difficult, limiting the government's ability to monitor the
potential arrival of members of radical terrorist groups.
Ratings: Stability Not Assured In Medium Term
Our political risk ratings make a clear distinction between what we
see as short-term stability and longer-term risks. In the near term,
robust oil revenues will allow sufficient social transfers to maintain
social stability, which will in turn provide the government with room
to continue its reforms of the business environment and increase its
attractiveness to foreign investors. Our short-term political risk
rating for Azerbaijan is 70.3 (out of 100), one of the highest in the
Central and Eastern Europe (CEE) region excluding the CE4. In line
with our key views, Azerbaijan scores most strongly on the 'policy
continuity' and 'policymaking process' components of our ratings - at
80.0 and 76.7 out of 100 respectively - while faring less well on
'security and external threats', where it tallies just 46.7 out of
100.
Over the longer term, we are less assured about political stability.
Although we continue to expect a mitigation of regional tensions at
some point, we believe the security situation in the Caucasus could
get worse before it gets better. This would have a greater relative
impact on political stability in Azerbaijan than in Georgia and
Armenia, in our view, given that its institutions are less well
prepared to handle the domestic implications of heightened tensions.
Azerbaijan's long-term political risk rating of 49.0 out of 100 puts
it lower down the CEE rankings, albeit still ahead of Georgia.
Azerbaijan fares worst in our 'characteristics of polity' (30.8 out of
100) category due to the relatively underdeveloped and closed nature
of its political and legal systems as well as the media. It also
struggles on the 'characteristics of society' component (52.5 out of
100), thanks to the potential for domestic opposition groups -
particularly Islamists - to hamper the policymaking process and due to
ongoing wealth disparities that have the potential to fuel
disenchantment with the government.
Our concern that Azerbaijan's institutions may be ill-equipped to deal
with the emergence or escalation of internal and external threats
relative to other CEE nations is demonstrated by the chart below,
which indicates the difference between our long- and short-term
political ratings. Aside from Turkmenistan and Kazakhstan, we believe
Azerbaijan is the CEE country where the political risk situation has
the greatest potential to deteriorate.
Scenarios For Political Change
While we believe domestic pressures from disenchanted groups could
impact the policy formation process in Azerbaijan through the medium
term, we forecast the major risk to political stability will come from
outside the country. Specifically, tensions with Armenia over the
disputed Nagorno-Karabakh enclave will dominate Azerbaijan's foreign
and domestic policy as long as hundreds of thousands of internally
displaced Azerbaijanis are unable to return to their former homes in
the region.
Best Case Scenario - Mitigation Of Regional Tensions: The best case
scenario for Azerbaijan's long-term political risk profile is a
resolution to its dispute over Nagorno-Karabakh. Any solution would be
threefold, involving an agreement on the terms of a future referendum
for the region's inhabitants, a roadmap for the return of displaced
Azerbaijanis to their former homes under the protection of a
multinational peacekeeping force as well as a mutually accepted
decision on who will control the Lachin corridor, a land route between
Armenia and Nagorno-Karabakh.
This would require two things. First, the continued involvement of
regional heavyweights Russia and Turkey, as well as major Western
countries such as the US and France (which, along with Russia, make up
the OSCE Minsk Group charged with coordinating discussions between the
disputed parties). It would also require the involvement of the ethnic
Armenian government of Nagorno-Karabakh - something that Baku may find
difficult to stomach. Second, it would require a major investment of
political capital by the presidents of Armenia and Azerbaijan. Both
are under intense domestic pressure to ensure that their key goals are
met over the enclave. Given that many of the countries' demands are
incompatible (ie Baku wants Nagorno-Karabakh to remain part of
Azerbaijan while Armenia wants the future referendum to include the
possibility of full independence), this will require the presidents to
go against popular domestic sentiment to secure a deal.
Should this scenario play out, we would expect it to substantially
improve Azerbaijan's political risk profile and significantly mitigate
regional tensions. This would bolster investor confidence, paving the
way for a ramping up on foreign direct investment, aiding the
government's attempt to diversify the economy away from its dependence
on oil and gas revenues.
Intermediate Scenario - Tensions Kept In Check: A far more likely
scenario is for tensions to be kept in check, without a major
improvement in relations or significant progress towards a mutually
acceptable solution on the enclave's future status. This would involve
the two sides continuing to talk and for Russia, Turkey and key
Western countries to maintain an important role in the dialogue. Under
this scenario, a stable platform would be provided for the discussion
of key sticking points, which would increase the chances of a
breakthrough.
The two sides continuing to talk would in itself increase investor
confidence, as long as the meetings are conducted regularly and
produce evidence of progress. In tandem with Azerbaijan's improving
business environment, this would bolster investor sentiment. At this
juncture, we see this scenario as the most likely to play out.
Worst Case Scenario - War: While the outbreak of war is always
difficult to predict, we believe that if war was to break out anywhere
in CEE in the next five years, it will be in Nagorno-Karabakh between
Armenia and Azerbaijan. As long as both sides continue to employ
aggressive rhetoric and regular exchanges of fire occur on the border,
there will always be the chance of a resumption of interstate war.
We caution, though, that this is highly unlikely to happen. This is
mainly because Russia - which still has 3,000 troops stationed in
Armenia - would likely step in, while Turkey would also likely make a
major effort to prevent an outbreak of fighting. The risk is that the
number of troops stationed on the border in close proximity to each
other could mean the situation would develop too rapidly for
international actors to be able to influence events, meaning that by
the time Moscow, Ankara and Western capitals were able to step in, the
damage may have already been done.
As long as the threat of war remains - and we fully expect it to -
investor risk sentiment will remain elevated and Azerbaijan will
struggle to attract the levels of foreign direct investment that it
needs to diversify its economy away from energy export. This will keep
it dependent on external demand, which poses the risk that a global
slowdown in economic growth results in a stronger domestic opposition
that could, in turn, hurt the government's reform agenda.
An outbreak of interstate warfare would hammer investor confidence,
leading to a massive withdrawal of funds from Azerbaijan and the wider
region, as well as undoing much of the economic growth that has been
achieved in the past 10 years. While Azerbaijan is not as dependent on
foreign capital flows as Georgia, the latter's experience of the 2008
war with Russia emphasises the extent to which warfare can damage
investor sentiment.
Political Overview Table
System of Government Presidential Republic (five-year term);
Unicameral 125-seat Milli Mejlis (National Assembly) (five-year term);
Universal suffrage. Executive power rests with the President.
Head of State President Ilham Aliyev; Three five-year terms
Head of Government Prime Minister Artur Rasizade
Last Election Parliamentary - November 7 2010
Presidential - October 9 2013
Government Formation Council of Ministers: appointed by the President
and confirmed by the National Assembly
Key Figures Finance - Samir Sharifov; Internal Affairs - Ramil Usubov;
Defence - Zakir Hasanov; Foreign Affairs - Elmar Mammadyarov; Energy -
Natiq Aliyev; Justice - Fikret Mamedov; Chairman of the National Bank
- Elman Rustamov
Key Political Forces (number of seats in parliament) New Azerbaijan
Party (Yeni) (72): Ruling political party. Founded by former President
Heydar Aliyev in 1993.
Civil Solidarity Party (3): opposition party which stands for the
civil unification of Azerbaijani people. Established in 1992 by Sabir
Rustamkhanly.
Motherland (2): Small pro-presidential party. The party was founded in
1992, and is led by former First Deputy Minister of Labor and Social
Protection, Fazail Agamali.
Independents (48)
Next Election Parliamentary - 2015
Presidential - 2018
Ongoing Disputes Nagorno-Karabakh
Key Relations/ Treaties Member of the Commonwealth of Independent
States. Member of the Organisation of the Black Sea Economic
Cooperation (BSEC)
BMI Short-Term Political Risk Rating 70.8
BMI Structural Political Risk Rating 49.0
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Source: CIA World Factbook, BMI